The U.S. government shutdown has left the Federal Reserve in a 'data vacuum,' which may force it to make December's interest rate decision without key employment and inflation data.

The ongoing government shutdown is putting the Federal Reserve in an exceptionally difficult position. If key employment and inflation data are still unavailable before the December rate-setting meeting, policymakers may have to make critical decisions in a 'data vacuum,' significantly increasing the likelihood of them blindly cutting rates along the established dovish path.

According to a report released by Bank of America on October 28, the possibility of the Federal Reserve being 'in the dark' at the December meeting is increasing. The report points out that not only is there no progress on ending the government shutdown, but even if the government reopens, data recovery may take months.

Data absence has intensified the existing divisions within the FOMC. The dovish camp, represented by Chairman Powell, may adhere to the rate cut path hinted at in the September 'dot plot.' However, hawkish members are likely to oppose a third rate cut this year in the absence of new evidence of economic weakness.

For investors, this unprecedented uncertainty has sharply increased the risks surrounding the December meeting. The final decision may no longer rely on the latest economic indicators but rather on the divided committee's trade-offs between old expectations and new risks. This could lead to both hawkish and dovish members casting opposing votes, adding greater variability to market expectations.

Data absence may exacerbate internal divisions

Bank of America analysis points out that the September FOMC meeting has exposed profound divisions among decision-makers in assessing the downside risks in the labor market. At that time, a slim majority believed these risks were sufficient to support a rate cut of at least 75 basis points this year.

In the absence of new data, the dovish group is likely to push for fulfilling the expectations set in the September dot plot. The report states that some dovish members even believe that a prolonged government shutdown itself will amplify economic downside risks, providing yet another reason to support a rate cut.

However, the hawkish forces should not be underestimated. The September dot plot shows that seven FOMC members support only one rate cut this year. Bank of America believes this camp includes Barr, Goolsbee, Musalem, and Schmid, four voting members. Although they are not expected to oppose a rate cut at this week's meeting, pushing for a third rate cut in December may be 'over the top,' especially with stable state-level unemployment claims data. This increases the risk of at least one hawkish dissenting vote at the December meeting, while dovish member Miran may also cast a dissenting vote.

Data recovery timeline determines policy path

The Federal Reserve's December decision will heavily depend on when the government shutdown ends and the progress of economic data recovery. Bank of America has proposed three scenario forecasts:

Scenario One: If the government reopens before the end of November, the market may see the September employment report before the December meeting. The report suggests that weak data will lower hawkish opposition risks, but even if the data is strong, it may be seen as 'outdated' and difficult to convince Powell to pause rate cuts.

Scenario Two: If the shutdown ends in early November, the Bureau of Labor Statistics (BLS) is expected to release two employment reports for September and October before the December meeting. If the unemployment rate remains at 4.3%, and economic activity data for September and October is robust, a 'pause in rate cuts' will become a possible option in December.

Scenario Three: If the government quickly reopens, the BLS conducts surveys for October and November simultaneously, releasing three employment reports before the December meeting. Bank of America proposes a decision-making rule: if the November unemployment rate is ≤4.3%, the Federal Reserve will keep rates unchanged in December; if the unemployment rate is ≥4.5% (consistent with SEP expectations), it will prompt a rate cut; if the unemployment rate is in the middle ground of 4.4%, the decision will depend on broader data, including inflation.